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topten October, 2010

This is a monthly reference source. By providing samples of questions and answers, we hope to help you understand that we provide a superior service in our ability to get answers to your questions. There are some general caveats that go along with this presentation. Understand that tax law is fluid and always changing; the answer that is correct today may be incorrect tomorrow. Also be aware that changing one small fact may change the entire answer. We are not trying to give a complete outline of any particular subject. We are attempting to give a general direction that can be taken to resolve a problem or obtain an answer. You should discuss your particular situation with your Fiducial Business Advisor to answer your specific problem or concerns. (You may not rely on any answer given to avoid a penalty.)


Q.1 I owned a rental property that I lost in foreclosure. The property was secured by a non-recourse loan (I was not personally liable for the mortgage- it was secured only by the property). The fair market value of the house was well under the mortgage balance. The amount of the mortgage debt exceeded my basis in the property. I was and remain solvent. Is there any tax issue?

A.1 As the property was secured by a non-recourse mortgage, on the foreclosure the property is treated as if it were sold for the amount of the mortgage remaining on the property regardless of the property’s fair market value. There is no debt relief income, but the entire principal balance of the mortgage must be considered the “sales price” of the property and any gain resulting from that “sale” must be reported (gain subject to Section 1250 depreciation recapture is subject to tax at a rate up to 25%).

Q.2 My rental property was foreclosed on during 2009. The property was secured by a recourse mortgage (I was personally liable for the mortgage), and the fair market value of the property was $100,000 less than the mortgage amount. The mortgage lender forgave the difference. Do I have a tax consequence?

A.2 As the rental property taken in foreclosure was secured by a recourse mortgage, the property is considered “sold” for the determined fair market value of the property and the excess of the mortgage principal forgiven over the value of the property is considered relief of debt. You should note that if the fair market value of the rental property is less than your adjusted basis in the property, you have a Section 1231 loss that will be available to offset the relief of debt income. If you were insolvent (FMV of assets is equaled or exceeded by debt) at the time of the foreclosure, to the extent of the insolvency there is relief from debt cancellation income. You would be subject to reducing tax attributes (any NOL carryover, tax credit carryover, depreciable basis, etc.).

Q.3 My client is considering a conversion of his traditional IRA to a Roth IRA. Is there a special rule for 2010 that may apply?

A.3 For conversions after 2009, the general rule that limits such conversions for individual with AGI in excess of $100,000 will NOT apply. Also, at the election of the taxpayer, the income generated from the conversion made during 2010 may either be recognized in its entirety on the Form 1040 for 2010, or the income may be spread ratably over the following two tax years (2011 and 2012).

Q.4 I purchased a new home in 2009 and claimed the first time homebuyer credit as I had been renting for many years. I just got a notice questioning the credit due to real estate taxes reported in a prior year. The property on which I paid the tax was raw land that I never used as a principal residence. What do I do?

A.4 Many taxpayers are receiving similar notices with regard to the credit. You should include in a response detail noting the property was never developed and was never used as a principal residence and include proof of your rental arrangement (rental contract, cancelled rent checks, utility bills sent to you at the rental address, for example).

Q.5 I was in an auto accident several years ago and brought suit against the other driver’s insurance company due to my injuries. I received a settlement (before trial), but had to pay my attorney out of that settlement. Is the attorney’s fee deductible?

A.5 As the lawsuit involved personal injury and any settlement related thereto is not taxable, the attorney’s fee associated with the recovery is not deductible.
Q.6 I am considering a large capital purchase for my business before the end of 2010. I was reading that the Section 179 limitation for 2010 is $134,000, but I also heard it is $250,000. Which of these is correct?

A.6 The HIRE Act, signed by the President on March 18, 2010, extended the $250,000 maximum deduction for purchases under Section 179 so as to apply through December 31, 2010. With the Small Business Jobs Act of 2010, signed into law on September 26, 2010, the dollar limitation for Section 179 was raised to $500,000 for 2010 and 2011 and the acquisition limitation was also raised from $800,000 to $2,000,000 for qualifying property. Without these extensions, the limit for Section 179 purchases would have been $134,000 with a $500,000 cap on purchases.

Q.7 My child is in college (claimed as a dependent) and works summers. I noticed her withholding was lower than normal. Do we need to make an estimated payment?

A.7 It is possible that an estimated payment may be recommended to avoid an underpayment penalty. The question is was enough withheld during the year to cover last years tax liability or 90% of the current year’s liability? If so, you are OK. Many dependent children that work are “coming up short” due to the “Making Work Pay” credit that dependent children are NOT eligible for that is factored into the payroll withholding tables causing less to be withheld.

Q.8 My husband passed away this year. All of our children are grown and on their own. None are dependents. Do I have to file “Married Filing Separate” if I do not remarry by the end of the year?

A.8 The general answer to your question is “No”. Generally, filing status is determined as of the end of the tax year. If you are named as the representative for his estate or there is none named by the time the tax return is due, you may elect to file jointly and sign “Surviving Spouse” in the space for your deceased husband. Otherwise, you may file as “Single”.

Q.9 I was discharged in a Chapter 7 bankruptcy last year. I managed to keep a few assets from my sole proprietorship business. The assets were not fully depreciated. May I continue to depreciate them now?

A.9 The basis of assets retained by you will likely be reduced by the amount of debt relief in bankruptcy. A Form 982 should accompany your income tax return for the year of the discharge of debt in bankruptcy. Tax attributes (net operating loss carryovers, credit carryovers, basis of assets, etc.) will be reduced by the amount of the debt relief. In most cases, the reduction in tax attributes, including basis reduction, due to debt relief leaves a taxpayer with no remaining basis to depreciate.

Q.10 My father passed away about halfway through last year. He had some income producing assets (several investment accounts). Once the attorney’s fees, appraisal fees and other estate administrative expenses for the 12 months following the date of death are tallied, the estate will likely have a net loss for the year even though dividend and interest income will likely be about $800. Do I still have to file Form 1041?

A.10 If the estate has more than $600 of gross income for the year or has any taxable income, an estate return is required. Remember that while an estate may have a fiscal year, that year may be no more than 12 months and must end on the end of the month preceding the month of death. For example if an individual passes away on June 9, the estate tax year may end on May 31 of the following year or may adopt a calendar year at the personal representative’s (executor’s) election.

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